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Interest Rate Cuts Aren’t Good News for Profit Forecasts, History Shows

(Bloomberg) — Equity markets have been rising in tandem with corporate profit estimates, buoyed by a resilient economy. But if history is any guide, looming interest rate cuts may flip the script.

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While markets have been eagerly anticipating rates coming down, that may not actually be a good thing for company earnings. Typically, the Federal Reserve cuts rates when the economy is heading for a recession — something that analysts’ optimistic projections don’t seem to be accounting for. In the US, some see the Fed cutting as soon as March, as inflation and producer prices are trending broadly lower.

“Declining profits and interest rates tend to go hand in hand,” Societe Generale SA’s Andrew Lapthorne said. Current estimates reflect a “very rosy outlook,” the quantitative strategist wrote in a note. “Is this the calm before the storm?”

Global stocks have been on a tear over the past year — soaring about 16% — supported by rising earnings forecasts. Margins are hovering near record highs, and analysts have continued to lift estimates.

UBS Group AG strategist Gerry Fowler said the market has benefited from lower-than-expected inflation, which allowed bond and equity valuations to expand.

From here, “either earnings estimates are revised lower, and prices move lower to reflect that, or interest rate cuts are priced out, and prices fall as multiples compress,” said Kyle Rodda, senior market analyst at Capital.com.

Looking ahead, the consensus view is still very bullish, with blended forward 12-month earnings for the MSCI World Index expected to surge 10% this year followed by more than 8% growth in 2025, according to data compiled by Bloomberg.

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Early indications from companies have been mixed. Burberry Group Plc slumped last week after the UK trenchcoat maker slashed its profit forecast, a fresh sign that demand for luxury goods is waning. And in December, FedEx Corp.’s shares tumbled after an earnings report that exposed weakness at the company’s express air business, with customers opting to send packages by a slower, less expensive mode of transport.

Still, Lululemon Athletica Inc., Abercrombie & Fitch Co. both raised their sales outlooks this month on the back of a strong holiday quarter, bucking fears of consumer weakness amid stubbornly high inflation.

So far, with soft-landing expectations being unchallenged by a still-strong US job market and consumer spending, companies are expected to sustain robust earnings growth, particularly in the technology sector.

In Europe, firms are also seen keeping pace this year, with 12% growth over the next 12 months. Negative profit revisions ahead of the fourth quarter earnings season have not altered the broadly upward trend of earnings estimates.

“Earnings headwinds remain under-appreciated,” Fowler said. “We still think that weaker inflation and nominal GDP growth puts margins at risk.”

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